The Dollar is Losing Momentum But Don’t Get Too Excited….

Posted onDecember 28, 2016

The Dollar is Losing Momentum But Don’t Get Too Excited….

Daily FX Market Roundup 12.28.16

The bulls have finally loosened their reins on the U.S. dollar but a move below 117 in USD/JPY is needed to pave the way for deeper reversal. The surprise decline in pending home sales combined with a sharp drop in U.S. yields sent the dollar tumbling against the Yen. However even with this decline the greenback managed to end the day in positive territory versus euro, sterling and Swiss Franc. The commodity currencies have found a near term button and chances are in the next 24 to 48 hours we should see a further pullback in the dollar. There are no U.S. economic reports scheduled for release tomorrow so all the dollar needs is another day of lower yields. Short-term price action aside, with the Federal Reserve looking to raise interest rates three times next year, 2017 should still be a good year for the U.S. dollar. Between Donald’s Trump Presidential victory, the surge in U.S. rates and record highs in U.S. stocks, global investors have found plenty of reasons to want to own U.S. assets and in turn the U.S. dollar. The moves that we have seen so far are in line with the market’s reaction to Ronald Regan’s election in 1980 and if Trump follows through we could see an even stronger rally for the dollar in 2017. Fiscal stimulus and rate hikes are a powerful combination but our positive dollar view is predicated on Mr. Trump delivering. In other words 2017 should be a good year for the U.S. dollar unless Donald Trump fails to deliver and the Fed resorts to raising interest rates only 2 instead of 3 times next year.

The worst performing currency today was the euro but thanks to a late day U.S. dollar sell-off, the currency managed to hold above 1.0350 and end the day above 1.04. After losing close to 1000 pips over the past 2 months, parity is in sight for the euro. However as weak as the euro may be, the slide in the currency is changing the outlook for inflation and growth. In the recent ECB economic bulletin, the central bank said they see inflation picking up strongly at the turn of the year, a view that the Bank of England shares. As a result, these 2 major central banks may need to start thinking about unwinding their stimulus programs in the coming year. The big question for Europe is whether a weak euro can save the Eurozone economy. We have no doubt that the lower currency will boost economic activity and inflation as the data already shows the positive impact. However Europe’s problems extend beyond day to day business activity. The greatest risk for the Eurozone and the euro next year are politics, terrorism, elections and a banking crisis in Italy. Many of these events are difficult to handicap but each of these scenarios could have a dramatic impact on the currency overshadowing positive improvements in the economy. Looking ahead we hope to sell rallies in the EUR/USD between 1.05 and 1.06 targeting a move to 1.01 or lower.

Sterling continued to trade lower against the U.S. dollar on the back of lower than expected mortgage approvals and ongoing Brexit concerns. Mortgage approvals dropped to 40.65K in the month of November from 40.83K. Economists had anticipated a rise but the sector is slowing and according to Halifax, the country’s largest mortgage lender, a “higher than normal degree of uncertainty” should lead to fewer house sales in the coming year with the most pronounced decline expected in London where affordability is already an issue. Meanwhile the call for a hard Brexit is growing with hardliners in the U.K. campaigning to put greater pressure on the EU. They believe that “businesses across Europe will want trade with the UK to continue as usual.” These are bold assumptions as EU leaders are also looking to take a hard stance on Britain. Either way, the coming year will be marked by uncertainty which is going to hurt more than help the currency.

The Canadian and New Zealand dollars ended the day lower against the greenback while the Australian dollar remained under pressure. Canadian yields have been falling for some time but it took the sharp drop in U.S. yields to turn USD/CAD around. Ten year Canadian rates dropped 6bp today while Treasuries with the same maturity fell 5bp. So not only should the Canadian dollar underperform the greenback but it should also see further weakness against the euro and Swiss Franc. AUD and NZD are showing signs of a near term bottom but rallies should still be sold.